(By Mani) VMware, Inc.'s (NYSE:VMW) acquisition of privately held Nicira may hurt Cisco Systems, Inc.'s (NASDAQ:CSCO) data center growth prospects in the long-term.
VMware bought Nicira for $1.26 billion to boost its software-enabled data center by introducing more agility and automation into the networking layer. Nicira is a network virtualization vendor, offering software (NVP )that is implemented on servers and managed by clustered controller architecture.
The thin software layer treats the physical network as an IP-backplane allowing creation of virtual networks with the same properties and services as physical networks. The virtual networks can be created dynamically to support VM mobility within or between data centers without service disruption or address changes.
Nicira claims that its solutions save between $8.8 million and $17.6 million in reduction of server over provisioning and $8 million to $16 million in reduction of cost per port in a 40,000 server environment.
Large-scale cloud service provider and data centers would be the key beneficiaries of such technology as they need to allocate data center networking resources dynamically and support large scale VM environments with little to no performance degradation.
Though VMware and Cisco are quick to point out that nothing is likely to change anytime soon with existing partnerships, in the long run, the deal may become a thorn in Cisco's path.
"We believe the concept of network virtualization is still in its infancy but in the long run can threaten Cisco as some of the network features are executed by the virtual layer vs. the physical switch, thus reducing its perceived value," Oppenheimer analyst Ittai Kidron said in a client note.
VMware aims to transform the traditional switch environment as it did for the server environment and Nicira's expanding client base should bring VMWare more closer to its potential goal. Nicira has been able to gain an expanding list of data center and carrier customers such as AT&T (NYSE:T), eBay (NASDAQ:EBAY), NTT, and Rackspace.
"While essential building blocks for data centers include servers, storage, security, networking and virtualization tools, we believe that a motivation behind acquiring a company with very little revenues stems from VMware's ambitions to become the dominant control plane of data center assets," RBC Capital Markets analyst Mark Sue wrote in a note to clients.
The concern for Cisco here is that the adoption of network virtualization solutions would reduce the value of the switch in the network by moving high-value network features from the switch to the network virtualization layer.
Moreover, VMware's view of data center automation may mean virtualizing a growing number of functions and over time, the company may increasingly become the centralized software asset, which runs across a range of hardware platforms. This push may create a value shift away from Cisco's routers and switches.
"This "dumbing down" process could reduce the value of the hardware and negatively impact networking vendors such as Cisco," Kidron said.
On the other hand, Cisco announced its plans for network virtualization (OPEN initiative) including support of OpenStack (cloud orchestration) on its Nexus 1000v providing cloud vendors with the ability to automatically provision network resources and expanded the hypervisor capabilities. Cisco has invested in Insieme, a private company specifically targeting this area.
Cisco, which remains on maintaining earnings growth given the challenging IT environment, is laying off 1,300 people as it looks to reduce further costs. The latest cuts are in addition to last year's 6,500 reduction.
It remains to be seen how all of this will play out for Cisco, but near-term Cisco's shares are likely to come under pressure. In fact, shares of Cisco fell about 6 percent during Tuesday's regular trading session.
"Investors have gained confidence in Cisco's ability to address network virtualization, but VMW can add more credibility to the threat and this could pressure the stock," Kidron added.